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The Strange Urge to Raise Rates

March 1, 2015 9:12 pmMarch 1, 2015 9:12 pm

Monetary policy attracts crazy people like moths to a flame; goldbugs, 100-percent-reserve-banking types, amateur historians who think they know exactly what happened when Diocletian ruled Rome but have no idea what
happened in Japan in the last decade. One thing that has surprised and depressed me in recent years, however, has been the obsession with raising interest rates among economists who used to seem sensible.

Five or six years ago, this was all about the allegedly imminent risk of high inflation. When that inflation failed to materialize, you might have expected a pause for reflection — an attempt to figure out why
they got it so wrong, and maybe even to figure out why some of us basically got it right. But no; instead we got either recapitulations of the original argument, with no acknowledgment of past failures, or new reasons
to do exactly the same thing, and raise rates.

The Bank for International Settlements remains tight-money central. But Marty Feldstein is effectively
shadowing the BIS position, with added conspiracy theory, and it’s kind of shocking to see.

Up to a point, Feldstein has followed the now-usual arc: first dire warnings that inflation is looming; then, after
years of inflation not happening, a quiet segue (or, as young people tend to write it, Segway) to “hey, what’s so bad about below-target inflation and maybe even a bit of deflation.”

You have to wonder: don’t the people making this new-reasons-for-the-same-policy switch feel even a bit embarrassed?

You also have to wonder about cognitive dissonance: in general, we’re talking about conservatives with vast faith in the wisdom of markets, who somehow are completely sure that markets will make terrible decisions
due to low interest rates, and require paternalistic monetary policy to keep them on the strait and narrow.

What really strikes me about Marty’s latest, however, is the muttering that there must be some sinister hidden agenda driving the anxiety of central banks about below-target inflation, given that classic deflationary
spirals don’t seem imminent.

Um, there have been many explanations of the current worry. The IMF published a very useful piece on why “lowflation”
brings many of the same risks as outright deflation. It’s widely understood that the financial crisis and aftermath make the zero lower bound — even if less binding than we used to think — a
very real concern, which means that not undershooting inflation targets is important. And the Fed is very much thinking about the example of Sweden, which decided to hike rates out of vague concerns about financial
stability, only to find itself staring at the very real risk of deflation.

Instead, however, Feldstein suggests — with not a shred of evidence — that central banks are operating under ulterior motives, notably a desire to help finance budget deficits.